Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo. He is the author of “Active Value Investing: Making Money in Range-Bound Markets” (Wiley 2007). To receive Vitaliy’s future articles by email send a blank email to ...

Should Investors Let Janus Out of the Doghouse?

If the years from 2000 to 2003 could be erased, what would people think of Janus today? History isn't that convenient, however, and the bear-market years--as well as Janus' involvement in the fund industry scandal of 2003--were indeed a humbling time for Janus and a painful period for its fund shareholders.

Yet, we think Janus is quietly re-emerging stronger and better than ever before. It has turned its focus back to investing, strengthened its central research pool, and become more sophisticated about risk. The firmwide improvements give us confidence in a handful of individual Janus funds that look quite attractive today.

The Disaster that Came from Quick GrowthOur willingness to look forward in Janus' case hasn't come without vigorous debate about Janus' current capabilities and a reflection on where we've been in the past. We've had very mixed feelings about Janus over the past 10 years. We liked several Janus funds in the 1990s when the firm was small and had a core competency investing in growth companies. Many talented managers, including David Decker, David Corkins, and Jonathan Coleman, grew out of Janus' research-driven processes in the early to mid-1990s.

In many ways, however, Janus was a victim of its own success. As fund returns soared in the mid to late 1990s, assets flooded into Janus funds. The biggest problem had as much to do with the velocity of flows than it did with investment process. The firm had a talented cadre of core managers, but it was taking in assets more quickly than its managers could put it to work in new ideas. Hence, Janus funds ended up with lots of overlap, and many of the analysts they did bring aboard were too new and inexperienced to realize that we were in a bubble. We're not letting Janus managers off the hook that easily, though. It was all too easy to forget about "risk" in the late 1990s because investors were rewarded handsomely for taking it and Janus managers--several of whom were experienced enough to know better--fell deep into that trap. We sounded alarms in our analyses of Janus funds about the sector- and stock-specific risks, but in hindsight they weren't loud enough. We maintained a positive outlook on many of the firm's offerings.

The asset growth and weakened research infrastructure were compounded by a combination of manager departures and the market timing scandal. Taken together, these events led us to seriously doubt Janus' culture and question where fund shareholders landed on the firm's priority list. To be sure, changes were definitely in order. Our concerns were so pressing, in fact, that we recommended that investors sell Janus funds in 2003.

The worst outcome, however, was that Janus investors got burned in worse ways than meets the eye. Janus funds were heavily marketed to individual investors in the late 1990s when most were simply attracted to the fund's hot returns. Those investors simply haven't made a lot of money by investing with Janus.

Investors' bad experience is painstakingly clear when you look at Janus funds' Morningstar Investor Returns. While total returns tell you how a buy-and-hold strategy fared over a given period, investor returns consider inflows and outflows to approximate the returns earned by a typical investor. Investor returns show just how badly investors actually fared with Janus funds when considering the timing of their purchases and sales. The average 10-year total return for Janus' funds was 9% through the end of February 2007, but the average investor made only 3.9% over that stretch. The disparity reflects that most of the money came in on the tail end of the bull market and left in droves as the funds crashed and the market-timing scandal surfaced. The results were especially bad for certain funds. Take Janus Enterprise JAENX, for example, its annualized 10-year total return is a positive 8.4%, but the average dollar invested in Enterprise lost 11.1%.

It's a New DayJanus has come a long way since its rapid rise and fall, and we think some of its funds are not only worth considering, but look like strong buys.

Janus was much too insular to see its weaknesses leading into the bear market, so fresh eyes were needed to help pull it through. Changes started to sweep Janus in the aftermath of the scandal and the bear market. As part of that effort, Janus hired Gary Black from Goldman Sachs as CIO in early 2004. Black later took the CEO post in 2006. He quickly revamped manager compensation plans to focus more on long-term results. He also remained committed to building a stronger research effort and taking a more systematic look at risk. He was willing to go outside of Janus to do it. Janus had historically hired analysts without experience, but it took several years to get them up to speed. Black, however, sought analysts with experience to effectively deepen the bench more quickly.PAGEBREAK

Janus' analyst staff certainly has matured in the past several years. Since the end of 1999, the typical analyst's years of experience has more than doubled to 5.4 years with Janus and 9.6 year of related industry experience. The number of stocks covered jumped from 500 to 1,200 over that same stretch.

Stronger resumes and more companies under coverage alone doesn't mean that Janus analysts are the best around. After all, several other fund shops boast similarly qualified analyst pools. But we've seen evidence that the research is indeed strong and the interplay between portfolio managers and analysts is working well. The improved performance across most Janus funds reflects well on the analyst team because a large proportion of fund holdings are rated highly by the analysts.

While the overall research effort failed in the late 1990s, talented analysts such as Minyoung Sohn and Ron Sachs still bubbled up to the surface in that environment and have since become good portfolio managers. Growing talent internally has worked well for Janus throughout its history and despite the research hiccups in the late 1990s, we think Janus will continue to be able to effectively churn out talented portfolio managers and retain experienced analysts.

Finally, Janus has pared back its previously bold marketing efforts. It has since shifted its focus from selling direct to individual investors to selling through financial advisors and institutions. It has invested in arming them with research and educational materials rather than trying to make a quick sell based on performance. We think that will help better the end investor's success with Janus funds.

There's a Risk Spectrum NowJanus managers can and do still take risk, but they are paying more attention to it. Gary Black hired Dan Scherman from MFS in Boston to monitor risk in each fund and across the whole lineup. We've seen some evidence that the increased focus on risk has influenced the funds, but they certainly haven't turned into index huggers. For example, the firm's boldest funds, such as Janus Twenty JAVLX, remain very aggressive, even though manager Scott Schoelzel is frequently reminded of his portfolio's sizable sector and industry wagers.

Though the funds haven't changed for risk reasons, we've watched two schools of thought emerge. Managers David Corkins of Janus Fund JANSX, Jonathan Coleman at Enterprise and Jason Yee at Janus Worldwide JAWWX are among the more risk-sensitive bunch while Scott Schoelzel of Janus Twenty, David Decker at Janus Contrarian JSVAX, and Brent Lynn at Janus Overseas JAOSX are more willing to take bigger bets. The bets differ from fund to fund, too. We see that as evidence that the managers are likely to challenge each other and the analysts because they're not all drinking the same Kool-Aid.

Will Janus Get Derailed Again?To be sure, Janus' funds didn't become bear-market proof overnight, nor do we think they should. Janus' strengthened research should help the funds navigate the next downturn better than the last and equip them for a variety of market environments. Personnel turnover has slowed considerably, the research effort has improved and the funds have gone back to the shop's less-aggressive growth-at-a-reasonable-price roots. The funds will not all shoot the lights out should more-aggressive growth take off, but that's not a widespread concern given that the managers have more divergent styles now. Janus' core competency is still rooted in finding good growth companies, making it one to beat when growth leads the market. We particularly like the firm's flagship funds, Janus Fund and Janus Worldwide, because both are well poised to benefit not only from talented managers who are mindful of risk, but also from Janus' stronger pool of research analysts.